Your questions: Markets and Macroeconomics

Your questions: Markets and Macroeconomics

We recently ran a webinar explaining how we had positioned our domestic funds as markets were peaking in February and ahead of the Coronavirus pandemic.  Attendees were shown our testing data analysis, as well as our suggested framework for navigating the market meltdown.  At the conclusion of the webinar, we invited attendees to submit their questions only some of which we were able to answer in the time allotted to us.

We were fortunate to be able to record all of the questions, and having collated them into broad topics, I plan to publish a few successive blog posts addressing those broad subjects. If you are looking for guidance in these uncertain times, we are delighted to help.

This edition’s ‘Question Thematic’ is Markets & Macroeconomics.

Q: How long will it take for the markets to recoup their loss last month?

That is a question to which there isn’t an answer.  It’s useful to know that the pandemic is usually worse than the pandemic.  That helps with perspective.  We can easily look back at previous corrections and the length of time the market took to recover in each scenario but any similarity this time around would be purely coincidental.  Each crash has nuances that stem from their causes, and the subsequent government and financial regulator responses as well as differences in terms of the sectors of the economy in which high debt levels might reside etc. Those factors will all contribute to the time for recovery.

The important thing is knowing that each has ultimately recovered, and great fortunes have been made in the past investing when it appears most uncomfortable to do so.

Q: Has the recent drop in markets been a correction in its own… or has Coronavirus been the cause?

Our view on this (just one firm’s view) is that the market had been expensive for a long time (hence our high cash levels). I would add that I believed there were bubbles in a variety of asset classes (witness the stupid prices being paid for start-ups and record prices for collectibles) that pointed to us being very late in the cycle.

In The Weekend Australian, back on April 22, 2018, I wrote; “And when it comes to equities, be certain of this: there are market darlings today whose share prices will decline 50, 60, 70 and even 90 per cent in the next 12-24 months.”

It’s now 24 months since the article was published and since then, the market had surged making the prediction look ridiculous.  But as the market surged, it became more and more vulnerable to any ‘black swan’ event.  We couldn’t predict COVID-19 but we did know the market was expensive compared to almost all measures of value.

So, the answer is that the market was already vulnerable but it took COVID-19 to pop the unrealistic expectations bubble.

Q: Which companies on the ASX are less reliant on China?

Start by thinking about sectors that are domestic-facing (retailers, banks, fund managers, REITS, developers, and many others) or earn dollars from global expansion beyond just China (Cochlear, RWC, CSL).  Then remove those that source their supplies from China, and you should be on your way.

Q: What’s the likely direction for the Aussie dollar?

The currency question is usually a tough one because most of the time the movements are just noise.  At extremes the likely direction becomes obvious.  At USD$1.05 the AUD is expensive and at US$0.55 cents its probably cheap.  In between it’s just noise.

Q: What do you think is the worst-case scenario for the Australian stock market from here? For example, 5000?

I am not sure levels are helpful.  Market bottoms when there is maximum panic, capitulation and a large number of deeply discounted capital raising.  My current view is that we aren’t there yet.  Ask me again in another month or three.  That’s when I think we will have seen the above three factors.

Q: Clearly there will be some volatility in the short term. What potential black swans do you see ahead?

By definition a black swan is unexpected.  In other words, we cannot know in advance.  I do believe however that inflation might be something we will be talking about (and markets possibly worrying about) in the next three years.

Q: Given gold is seen as a safe haven asset, do any of your funds hold positions in Precious Metals miners, or physical bullion to hedge against market downturns?

I am not sure that gold is anything other than a bet on others’ fears.  It’s not a currency, it won’t be one, and it’s not an ‘investment.’ If you look at its performance in US dollars over the last 100 years most other asset classes have outperformed, therefore gold cannot be called safe.  We don’t currently own gold miners in The Montgomery Fund but there is a thesis to do so and I can see merit in the short term if we see fears rise or the Aussie dollar decline substantially.

Q: If the economy and stock market continues to worsen, what do you think will happen to property prices? You seemed to suggest that house prices will continue to rise over the next couple of years?

I think property prices have risks.  My comment merely acknowledge that I hadn’t completely resolved the moving parts.  For example, there are eight million people who rent and a significant bunch of owners and renters are losing their jobs.  Take the example of a property owner with a mortgage that lives and rents elsewhere.  If they lose their job, they will be forced to move back out of the property they are renting and back into their owned property.  How do they then meet that mortgage?  And now that childcare centres are closing and parents are forced to leave work to look after children at home, even more people may be unable to meet mortgages and rent.  Yes, banks are offering pauses on repayments for six months but a spike in evictions and forced sales could put pressure on prices.  On the other hand this COVID-19 crisis will end, the W.H.O. will at some stage declare the pandemic over and then, gradually, everything will be restored, perhaps not fully, but the lows in asset prices may have been registered already at that point. So, I haven’t formed a clear view about property direction yet but I am biased to the downside in the short term. Long term, everything will return to normal.

Q: Re beneficiaries of consumer optimism going forward, you have identified FLT, WEB and SYD – these 3 stocks will most likely be affected more by the rebound on any good news re the Coronavirus rather than all the other companies identified given they are immediately affected by travel. So, they are likely to be the first to recover on good news re the Coronavirus?

I think you can add Qantas to that list.  Really important to look at balance sheets and understand who has the strongest net cash positions and understand cash burn if revenue is assumed to be close to zero.

Q: Recently commentators have been raising some concerns about the level of gearing in certain companies. What is Roger’s view about an appropriate level of debt to accept from a stock in the current climate and are Montgomery reviewing this in their funds and making adjustments given the mix of factors;  the late cycle, impending US election cycle and coronavirus?

One of our research priorities is making sure we understand a company’s balance sheet risks.  Cash burn, debt covenants and gearing are all important when one assumes that revenues are torched for this year and some of next.  Then we need to understand government legislation and policy settings regarding debt deferrals and business hibernation.  There’s a lot in that but as the market plunges there will be great value opportunities if you can find those businesses that survive first, and are then leveraged to the recovery.

Q: What potentially lies beyond the immediate response to coronavirus? Is the ‘lower for longer’ thesis still relevant beyond the US election or will Coronavirus create a whirlpool of change for markets and we find ourselves emerging next year into a slightly altered universe with momentum but a distant memory?

It is correct to assume low interest rates are supportive for asset prices but as I have always published, it is a mistake to conclude markets are immune to falls under any conditions.  Low interest rates in place during and after the conclusion of this crisis will mean a recovery in asset prices but then the issue will potentially be the deflation or maybe inflation.  Once again low interest rates are supportive but inflation or deflation changes the nuance.

We have also answered your questions about the current positioning across the Montgomery strategies, please see this article: Your Questions: Fund Positioning

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Roger Montgomery is the Founder and Chairman of Montgomery Investment Management. Roger has over three decades of experience in funds management and related activities, including equities analysis, equity and derivatives strategy, trading and stockbroking. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.

This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.